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Chapter 3 Homework

Managerial Cost Accounting (Eastern Michigan University)

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3-23 CVP analysis, changing revenues and costs. Sunset Travel Agency specializes in flights between
Toronto and Jamaica. It books passengers on Hamilton Air. Sunset’s fixed costs are $23,500 per month.
Hamilton Air charges passengers $1,500 per round-trip ticket.

Calculate the number of tickets Sunset must sell each month to (a) break even and (b) make a target
operating income of $10,000 per month in each of the following independent cases.

Required:
1. Sunset’s variable costs are $43 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
2. Sunset’s variable costs are $40 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
3. Sunset’s variable costs are $40 per ticket. Hamilton Air pays $60 fixed commission per ticket to Sunset.
Comment on the results.
4. Sunset’s variable costs are $40 per ticket. It receives $60 commission per ticket from Hamilton Air. It
charges its customers a delivery fee of $5 per ticket. Comment on the results.

SOLUTION
(35–40 min.) CVP analysis, changing revenues and costs.

1a. SP = 6% × $1,500 = $90 per ticket

VCU = $43 per ticket
CMU = $90 – $43 = $47 per ticket
FC = $23,500 a month

FC $23,500
Q = CMU = $47 per ticket = 500 tickets

FC + TOI $23,500  $10,000 $33,500

1b. Q = CMU = $47 per ticket = $47 per ticket = 713 tickets

2a. SP = 6% × $1,500 = $90 per ticket

VCU = $40 per ticket
CMU = $90 – $40 = $50 per ticket
FC = $23,500 a month

FC $23,500
Q = CMU = $50 per ticket = 470 tickets

FC + TOI $23,500  $10,000 $33,500

2b. Q = CMU = $50 per ticket = $50 per ticket = 670 tickets

3a. SP = $60 per ticket

VCU = $40 per ticket
CMU = $60 – $40 = $20 per ticket
FC = $23,500 a month

FC $23,500
Q = CMU = $20 per ticket = 1,175 tickets

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FC + TOI $23,500  $10,000 $33,500

3b. Q = CMU = $20 per ticket = $20 per ticket = 1,675 tickets

The reduced commission sizably increases the breakeven point and the number of tickets required to yield a
target operating income of $10,000:

6%
Commission Fixed
(Requirement 2) Commission of $60
Breakeven point 470 1,175
Attain OI of $10,000 670 1,675

4a. The $5 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost
offset. Either approach increases CMU $5:

SP = $65 ($60 + $5) per ticket

VCU = $40 per ticket
CMU = $65 – $40 = $25 per ticket
FC = $23,500 a month

FC $23,500
Q = CMU = $25 per ticket

= 940 tickets

FC + TOI $23,500  $10,000

4b. Q = CMU = $25 per ticket

$33,500
= $25 per ticket

= 1.340 tickets

The $5 delivery fee results in a higher contribution margin, which reduces both the breakeven point and the
tickets sold to attain operating income of $10,000.

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3-26 CVP analysis, income taxes. Westover Motors is a small car dealership. On average, it sells a car for
$32,000, which it purchases from the manufacturer for $28,000. Each month, Westover Motors pays $53,700 in
rent and utilities and $69,000 for salespeople’s salaries. In addition to their salaries, salespeople are paid a
commission of $400 for each car they sell. Westover Motors also spends $10,500 each month for local
advertisements. Its tax rate is 40%.

Required:
1. How many cars must Westover Motors sell each month to break even?
2. Westover Motors has a target monthly net income of $69,120. What is its target monthly operating
income? How many cars must be sold each month to reach the target monthly net income of $69,120?

SOLUTION
(10 min.) CVP analysis, income taxes.

1. Monthly fixed costs = $53,700 + $69,000 + $10,500 = $133,200

Contribution margin per unit = $32,000 – $28,000 – $400 = $ 3,600

Monthly fixed costs $133,200

Breakeven units per month = Contribution margin per unit = $3,600 per car = 37 cars

2. Tax rate 40%

Target net income $69,120

Target net income $69,120 $69,120

  
Target operating income = 1  tax rate (1  0.40) 0.60 $115,200

Quantity of output units Fixed costs + Target operating income $133, 200  $115, 200 
required to be sold = Contribution margin per unit $3, 600 69 cars

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3-27 CVP analysis, income taxes. The Home Style Eats has two restaurants that are open 24 hours a day.
Fixed costs for the two restaurants together total $430,500 per year. Service varies from a cup of coffee to full
meals. The average sales check per customer is $8.75. The average cost of food and other variable costs for
each customer is $3.50. The income tax rate is 36%. Target net income is $117,600.

Required:
1. Compute the revenues needed to earn the target net income.
2. How many customers are needed to break even? To earn net income of $117,600?
3. Compute net income if the number of customers is 170,000.

SOLUTION

(20–25 min.) CVP analysis, income taxes.

1. Variable cost percentage is $3.50  $8.75 = 40%

Let R = Revenues needed to obtain target net income
$117, 600
R – 0.40R – $430,500 = 1  0.36
0.60R = $430,500 + $183,750
R = $614,250  0.60
R = $1,023,750

Fixed costs + Target operating income

Target revenues 
or, Contribution margin percentage
Target net income $117, 600
Fixed costs + $430, 000 
Target revenues  1  Tax rate  1  0.36 $1, 023, 750
Contribution margin percentage 0.60

Proof: Revenues $1,023,750

Variable costs (at 40%) 409,500
Contribution margin 614,250
Fixed costs 430,500
Operating income 183,750
Income taxes (at 36%) 66,150
Net income $ 117,600
2.a. Customers needed to break even:
Contribution margin per customer = $8.75 – $3.50 = $5.25
Breakeven number of customers = Fixed costs  Contribution margin per customer
= $430,500  $5.25 per customer
= 82,000 customers

2.b. Customers needed to earn net income of $117,600:

Total revenues  Sales check per customer
$1,023,750  $8.75 = 117,000 customers

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3. Using the shortcut approach:

 Change in   Unit 
 number of    contribution    1  Tax rate 
 customers   margin 
Change in net income =    
= (170,000 – 117,000)  $5.25  (1 – 0.36)
= $278,250  0.64 = $178,080
New net income = $178,080 + $117,600 = $295,680

Alternatively, with 170,000 customers,

Operating income = Number of customers  Selling price per customer
– Number of customers  Variable cost per customer – Fixed costs
= 170,000  $8.75 – 170,000  $3.50 – $430,500 = $462,000
Net income = Operating income × (1 – Tax rate) = $462,000 × 0.64 = $295,680

The alternative approach is:

Revenues, 170,000  $8.75 $1,487,500
Variable costs at 40% 595,000
Contribution margin 892,500
Fixed costs 430,500
Operating income 462,000
Income tax at 36% 166,320
Net income $ 295,680

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3-28 CVP analysis, sensitivity analysis. Perfect Fit Jeans Co. sells blue jeans wholesale to major retailers
across the country. Each pair of jeans has a selling price of $50 with $35 in variable costs of goods sold. The
company has fixed manufacturing costs of $2,250,000 and fixed marketing costs of $250,000. Sales commissions
are paid to the wholesale sales reps at 10% of revenues. The company has an income tax rate of 20%.

Required:
1. How many jeans must Perfect Fit sell in order to break even?
2. How many jeans must the company sell in order to reach:
a. a target operating income of $420,000?
b. a net income of $420,000?
3. How many jeans would Perfect Fit have to sell to earn the net income in requirement 2b if: (Consider each
requirement independently.)
a. the contribution margin per unit increases by 10%.
b. the selling price is increased to $51.50.
c. the company outsources manufacturing to an overseas company increasing variable costs per unit by
$2.00 and saving 70% of fixed manufacturing costs.

SOLUTION

CVP analysis, sensitivity analysis.

1. CMU = $50−$35−(0.10 × $50) = $10

FC $2,500,000
Q = CMU = $10 per pair
= 250,000 pairs
Note: No income taxes are paid at the breakeven point because operating income is $0.

FC + TOI $2,500,000  $420,000

2a. Q = CMU = $10 per pair

$2,920,000
= $10 per pair
= 292,000 pairs

Target net income $420, 000 $420, 000

  
2b. Target operating income = 1  tax rate (1  0.20) 0.80 $525,000
Quantity of output units Fixed costs + Target operating income $2, 500,000  $525, 000

required to be sold = Contribution margin per unit $10

= 302,500 pairs

3a. Contribution margin per unit increases by 10%

Contribution margin per unit = $10 × 1.10 = $11
Quantity of output units Fixed costs + Target operating income $2, 500, 000  $525,000
required to be sold = Contribution margin per unit $11
= 275,000 pairs
The net income target in units decreases from 302,500 pairs in requirement 2b to 275,000 pairs.

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3b. Increasing the selling price to $51.50

Contribution margin per unit = $51.50 − $35 − (0.10 × $51.50) = $11.35

Quantity of output units Fixed costs + Target operating income $2, 500,000  $525, 000
required to be sold = Contribution margin per unit $11.35
= 266,520 pairs (rounded)
The net income target in units decreases from 302,500 pairs in requirement 2b to 266,520 pairs.

3c. Increase variable costs by $2 per unit and decrease fixed manufacturing costs by 70%.
Contribution margin per unit = $50 – $37 ($35 + $2) – (0.10 × $50) = $8
Fixed manufacturing costs = (1 – 0.7) × $2,250,000 = $675,000
Fixed marketing costs = $250,000
Total fixed costs = $675,000 + $250,000 = $925,000

Quantity of output units Fixed costs + Target operating income $925, 000  $525, 000
required to be sold = Contribution margin per unit $8
= 181,250 pairs
The net income target in units decreases from 302,500 pairs in requirement 2b to 181,250 pairs.

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